Energy crisis this time could be much worse

Dan Rice has been following the energy sector since the 1979 oil crisis, when fears of gasoline shortages led to long lines at gas stations. But Rice, manager of State Street Research Global Resources fund, believes the USA faces a much more serious energy crunch this time. Worldwide economic growth, particularly in India and China, has increased demand for oil. In the USA, production of natural gas isn't keeping pace with rising demand. Safety concerns have stalled construction of nuclear power plants for years. Alternative energy sources are decades away from widespread use.

Rice's fund is heavily invested in coal producers, drilling companies and exploration businesses. He invests primarily in small and midsize companies, which he believes are better positioned to benefit from rising commodity prices than large, diversified energy corporations. As of June 10, the fund was up 7.8%, vs. 3.0% for the Standard & Poor's 500 index (gains and dividends reinvested for both).

Q: The Organization of Petroleum Exporting Countries agreed to increase output by 8% starting July 1. What impact do you think that will have on oil prices?

A: We expect oil prices to come down to below $35 a barrel. But it's a moving target, and it has more to do with the fear factor of terrorism and possible gas shortages in the USA than it does with oil inventory levels. There should be enough inventory available in the next two months to take prices below that level, barring additional terrorist events. The world really can't tolerate a significant geopolitical event without causing prices to spike.

Q: How does this spike in gas prices differ from the 1979-80 energy crisis?

A: Back in 1980, worldwide demand was growing at 1 million barrels a day per year. Now, it's 2 million barrels a day per year. We only have 2 million barrels a day of spare capacity. We're much closer to the precipice of shortages than we were back then, and the demand number, because of the growth in the world (economy), is significantly larger.

Whereas back in 1980, there were plenty of opportunities to explore to find new reserves and get production up, we've done all that. We haven't had any major discoveries in the last five years.

We're kind of scratching our heads about where we will get growth and supply to offset demand increases. We don't see it. That means a couple of years down the road, it's going to be very tight or we're going to be much more dependent on foreign crude oil, much more dependent on OPEC, and much more helpless to change the tide and control OPEC will have over the oil markets.

What we're seeing today is just the precursor to things that can happen two or three years down the road. We're just getting kind of an early warning system.

Q: Your largest holdings are coal companies. Why are you so bullish on coal?

A: The stocks are discounting $38 per ton long-term steam coal prices. We think the price will be closer to $50 a ton, and on that basis, the stocks are doubles or triples beyond what they are today.

If electricity demand is to grow in the U.S., we don't have any other way of making that electricity unless we use more natural gas. If we use more natural gas, we won't have enough to heat our homes. Natural gas will go to $10 per thousand cubic feet. Politically, that can't happen. Half the U.S. population heat their homes with natural gas, and politicians will be voted out of office if prices get that high. Whether we like it or not, we're going to be forced to use more coal.

Back in the mid-1990s, the Clinton administration decided the best way to have cleaner air was to encourage natural gas being burned and discourage coal. The problem was, during those years where those policies were being put forward ... the lynchpin was the assumption there was plenty of natural gas to go around. All of this new demand would be met by supply. And the old plants that are the worst polluters, they didn't even put scrubbers on them because in a couple of years they would be obsolete.

Now those plants are being used 100%. We're forced to burn the coal in these lousy plants. Utilities can't afford to buy the scrubbers to put on their old coal plants.

My attitude is quit the squabbling. The government pays to put scrubbers on all the plants and charges the utilities for the use of those scrubbers. It's going to cost the taxpayers $50-$60 billion. That's life.

Q: But the USA has often been referred to as the Saudi Arabia of coal. Won't there be plenty of coal to meet demand?

A: The supply is actually quite limited, which is really a function of environmental litigation. When you try to open a new mine to get new supply, instead of taking three to six months like it did 15 years ago, now it takes two to four years. You've got to fight environmental lawsuits every step of the way.

Q: What about sources of alternative energy? Are there any investment opportunities there?

A: There's just not enough out there. Wind power in the USA is 2,000 megawatts a year. It will be up 50% a year in the next five years, and get to 5,000 megawatts. We need 20,000 megawatts a year of additional electricity capacity to satisfy demand growth in the country. And it's not investable because the largest wind power company is buried within General Electric.

The other alternative energies are so development stage, you don't know if they're going to make profits. In my portfolio are companies that are going to make a lot of money in certain industries, as opposed to guessing which technology is going to survive 10 years from now.

Which is why we don't have any alternative energy stocks. There are too many opportunities in things I can touch and feel right now.

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